FUNDS
Unlocking home values
Intellectual Property Magazine
Posted Fri, 09 Feb 2007

This year more and more mortgage bond products will come onto the market as banks and mortgage originators develop innovative devices to keep abreast of the stiff competition in the industry.

In a global sense, they are playing catch-up… in the UK, for instance, there are in excess of 300 home loan variations on offer. Already South African consumers can opt for fixed interest bonds, which generally provide them with short term relief from rising interest rates, as opposed to the more traditional variable rate product.

Since both lender and borrower are taking a gamble on the Reserve Bank’s monetary policy, these are charged at a premium by the banks so the key is to beat the accumulated interest rate increases — which now total two percent since the middle of last year. Thus, if moving to or taking out a fixed rate bond costs you an additional two percent, you break even — hardly worth the bother or the additional cash flow possibly incurred.

Equity release

A new mortgage product, aimed specifically at the retired market, is the “lifetime mortgage”, also known as “equity release”. The latter was introduced to South Africa late last year amid some controversy. But so far, of the major banks, only Nedbank has taken the plunge with its Home Income Plan. The key to both these products is basic: strong house price growth and low, or relatively low, interest rates.

With these in place both lenders and borrowers are in a position of low risk and reasonably good security. That’s why over the past five or six years the UK and Australian lifetime mortgage markets have blossomed.

Basically, equity release is just that. It allows retired persons or couples the opportunity to unlock part of the capital that has accrued in their homes without, unlike a conventional mortgage, repaying the capital plus interest in monthly instalments.

Forced to sell homes

You get cash up front, the interest compounds and when you die the bank sells the house, takes what it’s owed and any profit left over goes to your estate. In the UK an estimated 45 percent of the retired population are homeowners but have inadequate pension income. Many still have mortgage bonds — and a recent report by the charity Citizens Advice found that around 770 000 people had missed one or more mortgage repayments in the past year as they struggled with debt. Another charity, Help the Aged, reports that half the UK population nearing retirement will be forced to sell their homes to pay nursing and health care bills.

In South Africa, only an estimated six percent of the population will retire with sufficient income to maintain their standard of living. Again, many retired people still have mortgage bonds; as interest rates rise they find it harder and harder to meet their monthly repayments.

Lifetime lease

The lifetime mortgage is offered in South Africa by Nedbank. It is a loan granted to a homeowner(s) using the collateral in his or her residential property. A legal charge is secured on the home and the loan, either a lump sum or by drawdown, can be spent as the applicant wishes, subject to the repayment of any existing mortgage.

The applicant and spouse can continue to remain in the home as long as they live (ie. if the husband dies first, the wife may remain in the home until she dies or opts to move elsewhere, such as to join her children or move into a nursing home).

With a home reversion scheme the lending institution actually buys the property — or a portion of the property — and grants the owner/spouse a lifetime lease without repayments. This system enables homeowners to unlock more cash than with the lifetime mortgage and enables them to retain equity should they wish.

One issue that requires consideration in South Africa is that of governance. The money advanced under these schemes is deemed a loan and therefore does not fall under the scrutiny of the Financial Services Board, although such loans will fall under the National Credit Act, which kicks in in June.

Basic problems

In the UK lifetime mortgages in the 1980s got a bad name (basically through bad product design). But in 1991 the major lending institutions banded together and formed an association, Safe Home Income Plans (SHIP), which created a code of practice both for lifetime mortgages and home reversion schemes.

David Classe, MD of Stonecastle Trust, which produced and runs Nedbank’s plan, says the infant South African industry is forming a regulatory body. So who can apply for a lifetime mortgage and how much cash can be released?

There are, as one can expect, some basic differences between overseas schemes and those offered in South Africa. Local financial institutions, other than Nedbank, are appraising this market, but may not necessarily enter it. There are some basic problems.

The economy is one. When interest rates here fell steadily over the past few years and house prices boomed, so much equity was locked into the residential property market that everyone — banks and customers — were at little risk. But the tables have turned.

Higher interest premiums

By their very nature, lifetime mortgages attract an interest rate premium — current products charge 13.95 percent, although “best” clients may pay a little less. At that rate a loan will double within 5.16 years.

With real average house price growth projected at three percent (nine percent nominal less inflation), the scheme looks more than a little risky.

As Standard Bank home loans division analyst Gina Schoeman comments: “This type of product would have been more appropriate in the South African market three years ago.”

Furthermore, South Africa’s in duplum law raises another potential stumbling block. This states that a lender cannot seek to recover interest accrued in excess of the principal sum loaned.

Thus, if we use the example above in terms of a lifetime mortgage, at 5.16 years that point will have been reached! The in duplum rule is most probably the reason why Nedbank’s product, called the Home Income Plan, is limited to five years.

Must repay

Thereafter, the holder of the mortgage must repay it. The bank’s application brochure states: “At the end of the five-year loan period you must repay the loan. This you can do through other funds (sic), from the sale of your home, or you could of course apply for a new plan. At this point your new loan will be priced at a rate linked to the prevailing prime rate, again fixed for a five-year term.”

Note that the bank does not state that the mortgage can automatically be rolled over, simply that you can apply for a new one. On this basis it can hardly be termed a “lifetime” mortgage — possibly the reason the bank decided to call its product a home income plan.

And therein lies the risk to the borrower — no guarantee that five years down the line another plan will be approved. Applicants must be between the ages of 65 and 85 (both parties). In the UK the lower age limit is generally 60 for equity release products.

However, Nedbank does say that younger or older applicants can be considered under special circumstances. This highlights yet another hiccup — the age gap.

Married men are generally older than their wives. So if the husband were 65 and his wife, say, 59 they would not qualify. With the Nedbank product the minimum amount of loan is R250 000.

Stumbling block

David Classe advises that between 10 percent and 45 percent of the value of the property can be advanced.

“The valuations are very thorough and are carried out by independent certified valuers,” he points out. Retired people sitting with an existing mortgage can borrow through the plan to pay off the serviced bond as long as this bond is not more than 85 percent of the funds released.

Classe stresses: “We actively highlight to clients who want to switch that the unserviced bond will almost certainly be priced at a premium and should therefore be carefully considered.”

A further serious consideration is the issue of inheritance. Savills’ Mick Ferrucci says the subject has to be handled delicately. “We always suggest clients sit down with their heirs and, preferably, their solicitor and discuss the issue.” It can be a stumbling block, but research carried out in the UK by Key Retirement Solutions found that eight out of 10 children were supportive of their parents’ decision to take out an equity release plan.

Peter Couch of Grainger Trust, a leading UK home reversion provider, points out that through this type of scheme the borrower can still guarantee an inheritance by selling only a portion of the equity.

And for many children, an equity release plan can relieve them of the burden of having to support ageing parents with inadequate retirement income. It’s early days yet. No doubt we’ll be hearing much more about lifetime mortgages in the coming months.